Your kid's in college! So... how will you pay?

You knew college wasn't cheap, but actually seeing the bills is total sticker shock. Welcome to our crash course in handling it.

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By Amanda Gengler, Money Magazine writer-reporter

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Patrick and Laura Matheny, with Natalie, 18 and Daniel, 20.
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3 fast fixes
With two tuition bills to pay this fall, Patrick and Laura Matheny need to make better use of their resources, says Mark Kantrowitz, publisher of FinAid.org.
1. Re-assess the house
The Mathenys recently cashed out $200,000 in home equity. Since the money increases their assets, however, that reduces the aid they will get next year. They should consider returning the equity to the home and taking more loans instead, using equity to pay them off later.
2. Drain the 529
The assets earmarked for Natalie's tuition are in Patrick's name, so the money will be assessed at a lower rate on her financial aid application next year. But since it still does lower her aid somewhat, the Mathenys should spend the money as soon as possible to potentially up next year's aid package.
3. Cosign the loans
If there are two borrowers on a loan, lenders will base their rates on the higher credit score. Since neither Daniel nor Natalie has much credit history, either Patrick or Laura should cosign for their private loans. That way the kids might qualify for a discount of perhaps as much as one percentage point.

(Money Magazine) -- Patrick and Laura Matheny began saving early for their children's college education. After stashing some $50,000 in college savings accounts for their son Daniel, now 20, and their daughter Natalie, 18, they began paying down their mortgage in earnest with the intention of tapping their home equity once the bills began rolling in.

But with Daniel heading into his third year at Georgetown University and Natalie starting at Tufts University in the fall, the Mathenys are looking at a $100,000 bill for the next school year. And then another one after that. "It's costing us even more than we expected," says Patrick.

The Mathenys, who received just $10,000 in financial aid from Tufts (they haven't heard from Georgetown yet), have refinanced their Fairfax, Va. home, pulling out $200,000 worth of equity. They figure that sum plus Natalie's 529 plan will fund a big chunk of the next six years, but they'll need to rely on loans and income too.

Still, Patrick, 54, and Laura, 48, are determined that their kids be able to go to these private schools. "It's what we get for promising them they could go to any college they wanted to," jokes Patrick.

As 2 million high school seniors eagerly plan for their freshman year by thumbing through class catalogues and updating their Facebook pages, millions of parents nervously wonder: How exactly will I pay these bills?

In the event that your child attends a relatively inexpensive in-state public college, you're likely looking at a $13,600 tab next year. If she is heading to an out-of-state or private college, you might be on the hook for two or three times that much.

You could be facing a vast shortfall despite having saved diligently for years. What's worse, time's up: Your first check may be due in two or three months. Catchup time is over. But before you throw up your hands and tell your kids to forgo college in favor of plumbing school, follow this plan.

Calculate your total due. Even if you have a six-figure income, you probably won't be stuck paying the full price in cash. If you filled out the free application for federal student aid (FAFSA) earlier this year, you should know by now whether you're getting any aid in the form of grants, work-study or subsidized loans (the government pays the interest on these loans while your child is in school). The rest will have to come from your savings, income and unsubsidized government or private loans.

One piece of good news: You probably don't have to write a check for an entire semester all at once. For a nominal fee of $50 or so, many schools offer payment plans that let you stretch the bill over nine months or even the entire year; contact the financial aid or bursar's office for more information.

Keep an eye on future aid. If you didn't qualify for aid this year, don't assume you have no shot at getting some next year. Keeping your odds up is tricky. Generally you want to spend any money that's in your kids' name first because aid formulas assume students will use a larger share of their savings than their parents will (money in a student-owned 529 or Coverdell account isn't counted in the formulas for now).

Still, kids first isn't always the right strategy. Liquidating these funds could trigger big taxes, and the income you collect from the sales could lower your aid next year. "It's a double whammy," says Joe Hurley, founder of Savingforcollege.com.

You may be better off cashing in savings for senior year (when the following year's aid is no longer an issue) and taking out more loans now, says Hurley. Use the EFC calculator at finaid.org to determine which funds, if any, you should spend today to get the most aid next year.

Max out federal aid. You may be reluctant to saddle your child with so many loans that he ends up sleeping on your couch after graduation. But at the very least, your kid should first take out the maximum amount in federal government aid, generally a Stafford Loan (freshman undergrads typically can borrow $3,500 in Stafford Loans, rising to $5,500 for juniors and seniors).

For the upcoming school year, rates on subsidized Stafford Loans are fixed at 6% (6.8% for unsubsidized loans), and most lenders offer flexible repayment options such as payments based on how much you earn or hardship deferments if you can't find a job or are laid off.

Chances are, of course, that $3,500 isn't nearly enough. From there you have a choice of private loans, which are generally variable rate, and federal loans for parents, known as PLUS loans, which have a fixed rate of 8.5%. Which is better depends on the rates you qualify for, as well as how quickly you think you'll pay back the loan.

Some major lenders have abandoned the student-loan market in the wake of the credit crunch, making loans scarcer and sometimes more expensive, but if you shop around you still may find private lenders willing to beat PLUS loan rates. Start your loan shopping at your college's financial aid office, which may be able to directly provide federal loans.

But given last year's scandals involving alleged kickbacks to school officials who steered students to certain lenders, you'll also want to look on your own to make sure rates and fees are competitive. You can find a list of lenders at finaid.org.

When comparing private loans, don't just look at rates: Also consider origination fees, repayment options and whether there are ways to obtain discounts, such as by setting up automatic payments from your bank account. You should consider cosigning for private loans, since you'll likely qualify for a lower rate than your child based on your higher credit score.

You should also look for loans with an interest rate tied to the Libor index, says Mark Kantrowitz, publisher of FinAid.org. When rates begin rising again, those loans should not climb as high as loans based on other indexes. Today you may find better rates and terms at big banks such as Chase (ChaseStudentLoans.com), which face fewer problems than many nonbank lenders, says Kantrowitz.

Raid your home. With rates on home-equity lines of credit averaging just 6.1%, tapping your equity may be an appealing option. Normally a HELOC makes more sense than a lump-sum loan since it lets you borrow small chunks over time. But don't forget that these too typically are variable-rate loans that could later become much more expensive. Plus, if you live in an area with falling property values, lenders might freeze your HELOC or refuse to let you take one altogether.

You may have a better chance of qualifying for a cash-out refinancing, but bear in mind that the additional assets could lower your financial aid. The Mathenys likely would have received more aid this year had they not pulled $200,000 worth of equity from their home.

Create a backup plan. If all else fails, resist the temptation to empty your retirement accounts even though IRA withdrawals for college are penalty-free. A better option might be to appeal to your parents. Grandma and Grandpa can each give up to $12,000 a year per child gift-tax-free. If you qualify for financial aid, tread carefully since the additional assets will count against you for next year's financial aid package.

Most schools also count money sent directly to the college as income, which again would likely lower your aid the following year. You may want to have your parents wait until after graduation and then give the gift to the student to help pay off loans, says Kantrowitz.

The Mathenys were happy to borrow from their home, but they don't see anything wrong with kids graduating with some debt too. Says Patrick: "Hopefully the loans will give the kids a lesson they wouldn't learn in a classroom: financial responsibility."

Are you on track for an early retirement? Tell us why and send us your photos and videos. Include your financial details and your family could be profiled in a future column of our Millionaire in the Making series.  To top of page

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